A note on studies of monetary policy and implementation in vietnam (2)

Keywords: Vietnam; market economy; monetary policy; exchange rate regime JEL Classifications: G10, G18, E22, E31, E44.. The main theme of our discussion concentrates on the breadth and d

A N ot e on St u die s of M on e t a r y Policy a n d

I m ple m e n t a t ion in V ie t n a m

V u on g Qu a n H oa n g a n d Tr a n Tr i D u n g

I n t his shor t paper , w e have gone t hr ough som e k ey r esult s of m onet ar y policy

r esear ch applied for t he Viet nam ese econom y, over t he past 20 year s aft er Doi

Moi, t oget her w it h a few caveat s w hen put t ing t hese r esult s in use We look at

differ ent r esear ch t hem es, and suggest t hat fut ur e r esear ch m ake bet t er and

m or e div er se choice of analy t ic fr am ew ork, and also put m acr o and m icr o- set t ing connect ion at w or k, w hich appear t o likely br ing about bet t er and m or e insight ful

r esult s for t he m onet ar y econom ics lit er at ur e in Viet nam

JEL Classificat ions: G10, G18, E22, E31, E44

Key w or ds: Viet nam ; m ar ket econom y ; m onet ar y policy; ex change r at e r egim e

CEB Wor k ing Paper N° 09/ 024

June 2009

Université Libre de Bruxelles - Solvay Brussels School of Economics and Management

Centre Emile Bernheim ULB CP145/01 50, avenue F.D Roosevelt 1050 Brussels BELGIUM

A Note on Studies of Monetary Policy and

Implementation in Vietnam

Tran Tri Dung† Centre Emile Bernheim Working Paper

WP-CEB No 09-024 June 12, 2009

Abstract:

In this short paper, we have gone through some key results of monetary policy research applied for the Vietnamese economy, over the past 20 years after Doi Moi, together with a few caveats when putting these results in use We look

at different research themes, and suggest that future research make better and more diverse choice of analytic framework, and also put the macro and micro-setting connections at work, which appear to likely bring about better and more insightful results for the monetary economics literature in Vietnam

Keywords: Vietnam; market economy; monetary policy; exchange rate regime JEL Classifications: G10, G18, E22, E31, E44

∗ Dr Vuong Quan Hoang is corresponding author Dept of Finance, Centre Emile Bernheim, SBS-EM, Universit´e Libre de Bruxelles, Belgium Email: qvuong@ulb.ac.be or hoangvq@empirics.net

† Dan Houtte, Vuong & Partners (http://empirics.net), Hanoi, Vietnam.

1 THE BACKGROUND

The Vietnam’s economy has embarked on its extensive economic reform pro-gram (Doi Moi) since 1986, de jure Over the past 22 years, professionals, policy makers and normal workers in Vietnam have struggled to learn what the market economy really means to them, and what more need to be done, and in which direction, to build a genuine market economy

The economy of Vietnam has gradually turned from a pure centrally planned model (also called command economy) to a more market-oriented economy The amended Constitution 1992 recognized the private sector econ-omy and legality of systems of market as an integral part of the econecon-omy People have since enjoyed more freedom to conduct trade, set up privately held companies The country’s per capita income increased from as little

as $210 when Doi Moi started in 1986, to over $900 by the end of 2008, a spectacular growth rate, although it is still a low level of per capita income

to international standards

Of course, there have been many problems and issues arising during the process of transition to a full-fledged market economy, no matter how im-pressive the outcomes of Doi Moi appeared to be One may refer to typical research works in Vietnam for a better and in-depth understanding, such

as Lipworth and Spitaller (1993), Fforde and de Vylder (1996), Riedel and Turley (1999), Riedel and Leung (2001), and so on Many historical and remaining issues in both macro and micro settings of the Vietnamese econ-omy have also been well documented in different series of working papers by the International Monetary Fund, the World Bank, the Asian Development Bank, etc as key donors to Vietnam

What we would like to discuss in this paper is, however, not to look at the problems and issues, which still remain in the emerging economy of Vietnam, and perhaps will be remaining for a while The main theme of our discussion concentrates on the breadth and depth of different studies with respect to Vietnam’s monetary policy and implementation since the beginning of its transition process The rationale for this is going to be justified now

1 THE BACKGROUND

The underlying rationale: The history of economic reform in Vietnam witnessed periods of turbulence, in which new source of risks were gradually

“introduced” into the overall economic settings In each period, there are specific issues that give rise to period-specific studies Nonetheless, issues in relation to monetary policy have always been critical to Vietnam’s economic development

In the 1986-19887 period, inflation had at some point in time peaked at 774% per annum After a short while of successful disinflation, the general price level jumped to 385%, in 1988 The stabilized level of CPI in Vietnam after 1988 was also short-lived Inflation went up again in 1990-91 period, when the annualized peak reached the level of greater than 90%

After a decade of stablized prices, Vietnam’s inflation went up to two-digit level again, standing at the annualized CPI growth rates of 12% and 19.9% in 2007 and 2008, respectively, reminding consumers and the govern-ment of the hyperinflation and high inflation nightmares Till late 2008, the battle against inflation was still being of primary concern to the whole coun-try, stipulated in all decisions set out by the congress and the government, because in the first half of 2008 annualized monthly CPI at times exploded

to the level of 30% p.a (Vuong and Pham, 2009.)1

All these events give rise to monetary policy and its implementation at the national level The efforts made for successful disinflation in Vietnam usually involve a determined stance of monetary policy, together with required tools avalaible in Vietnam They also caused several serious adverse effects on the economy, namely inappropriate exchange rate policy, significant reduction

of liquidity to the banking sector, overshooting overnight interbank rates (that usually sparks further concern of future liquidity trap) and contracted output level of the economy These have been genuine observations from the economy, no matter whether or not Granger causality confirms them or what stylized facts induced from short-run equilibrium tell us Truths are there for us to perceive

On the other hand, we have seen the fact that a number of analyses on monetary plicy and implementation in Vietnam, although there have been

1

Since mid-2008, Vietnam’s General Statistics Office has changed its basis of CPI rate computation and release to year on year comparative statistic.

2 THEMES OF RESEARCH

not many of them available to access, tend to discuss isolated issues in relation

to monetary policy It is our obligation to see the whole thing, and under-stand the operation of the economy in an interconnected manner Bearing this in mind, this paper is to perform part of the task, trying the under-stand what have been done and what more to be done to grasp a truthful knowledge of monetary policy implementation in Vietnam

Organization of the paper: This paper has three main sections The first part looks at specific themes of research in monetary policy and im-plementation that have been chosen by researchers We try to observe the breadth and explain the issues relating to that The second section is to sum up key results obtained from studies performed by different researchers, with the purpose of understanding how critical monetary issues have been researched thus far and why In other words, we would like to view the depth

of these studies Last, but not least, we put down some final remarks after reviewing the literature

Before 2001, there had been virtually no specialized studies dedicated to the issues of monetary policy in Vietnam, whether with concentration on theoretical modeling or finding of empirical evidences Both modeling and econometric methods were not available and popular then in Vietnam Ma-jor insights came from descriptive economic analyses, using basic “number-crunching” for past-against-present comparison, or gap analysis between eco-nomic goals2

and actual realizations

General descriptive theme: It is understandable that before 2000, the use of general descriptive theme of research is a rational choice and more useful for understanding of both Vietnamese technocrats and foreign donors / investors who would more often like to have a broad view of the economic situation in Vietnam

2

Goals are usually set out in plans and decisions by the Government and the National Assembly on an annual basis, at the beginning of the fiscal year.

2 THEMES OF RESEARCH

Basic understandings and first insights about Vietnam’s monetary policy,

in its infancy, could be found in the early works written about the Vietnamese economy, namely Lipworth and Spitaller (1993), Fforde and de Vylder (1996), Riedel and Turley (1999), Shimomoto (1999)

Following these works, the broad audience could gain an overall under-standing of the broader socio-economic situation of Vietnam, together with key insights, in a reasonable depth, about how monetary policy functioned and impacted other critical economic decisions Basic economic statitics in these works are organized in useful ways to unveil the economic mechanism,

in general, and how the monetary policy should be separated from fiscal ac-tivities Grown up from works these, the State Bank of Vietnam (the central bank) and the Government has gradually embarked on the important process

of designating the State Bank to act as increasingly more independent factor

of setting and pursuing own monetary policy

Without using highly technical tools these studies contribute a great deal

to our understanding of the Vietnam’s economy, and even though monetary policy was then not their concentration, different insightful discussions have drawn a substantially increasing attention by national economists, profession-als and policy makers towards monetary issues, in a much better analytical framework

Modeling and general theoretical discussions: The theme of model-ing research was supposed to develop subtantially durmodel-ing the firsth 10 years

of Doi Moi, with respect to monetary economics and policy implementation However, our observation is that the efflorescence of monetary modeling has never been the case in Vietnam Surprisingly, the volume of works on model-ing Vietnam-specific monetary policy is almost neglible, and of no significant importance

However, since the degree of adversity caused by monetary problems keeps inreasing, together with an increasing awareness of the public, economist, policy makers, there exists a trend of general theoretical discussions, with mixed contributions by international researchers (mainly from ODA donor countries) and national economists

In the first place, these might look similar to the general descriptive

2 THEMES OF RESEARCH

theme However, there is one important difference In the advent of bet-ter developed sectors of Vietnam’s market economy, the economic studies gradually become more sector-specific, with significant concentration on the-oretical aspects Therefore, the thethe-oretical discussions about monetary policy

in Vietnam have been a trend, still going on now

The majority of these studies mostly emphasize on the foreign exchange regime, inflation, and anomalies in credit flows to economic sectors of the economy, such as Nguyen (1999), Riedel and Leung (2001), Vuong and Ngo (2002), Tyers and Reeds (2002), Ohno (2003), Camen (2005), Mai (2007), Parkard (2007), Vuong et al (2008)

This academic theme on monetary policy research upto now constitutes the largest portion of Vietnam’s monetary economics literature

Applied econometric studies: There have also been an increasing num-ber of studies employing econometric methods to investigate monetary pol-icy issues since 2000 This perhaps becomes an apparent trend, especially in studying short-run relationships between macro-economic factors and mon-etary supply (base and extension), US Dollar and local currency exchange rate, commercial rates/spread, and consumer prices

Although the studies employing general theoretical discussions have been populated, they rarely come to specific findings The majority of conclu-sions are suggestive, with main use for general understanding (in principal) Econometric analyses come in place as a more statistically inclined method-ology, which have provided for more or less practical usage and implications

in formulate policy and partly guided implementation on a better agreement among financial market players and policy makers

However, more empirical studies were skewed to market and policy is-sues, where data were in general easier to access and were better organized, such as foreign exchange rates, and sometimes, interest rates as monetary transmission mechanism

Some typical applied econometric studies that provide for original under-standings and insights on monetary economics in Vietnam include Vuong and Ngo (2002), Adam et al (2002), Vuong (2003), and Le and Pfau (2008) Clearly, the number of applied econometric studies is small by all means

3 RESULTS OBTAINED AND CAVEATS

In addition to that, the narrow range of issues investigated by this analy-sis method also shows a severe limitation of monetary economics literature available and accessible in Vietnam

Now we appreciate the fact that there have been a handful of scholarly studies

on monetary policy and implementation in Vietnam The low volume of research literature indicates a correspondingly poor outcomes, that says not many insights and substantial knowledge have been provided to the audience, both in the academic and policy circles

Some key results It is to our advantage to review the results from the said studies in a more systemic manner, towards the whole target of Vietnam’s economic development.3

Early works before 2000, such as Lipworth and Spitaller (1993), Shimo-moto (1999), Riedel and Turley (1999) suggest several important insights Since the start of a nascent market economy, macro-economic conditions such as credit flows, fierce fights against hyper- and recurring high infla-tion, overwhelming task of supporting export-led growth, etc have place monetary policy and implementation increasingly high on the governmental agenda The monetary policy was then suggested to be performed in a better collaboration with fiscal policy The trend of making Vietnam’s central bank more independent was put forward early on, in absence of foremost priorities and degree of independence desired

These studies also indicate the importance of better managed bond is-sue, together with the building of a smooth functioning bond market, which combined together could form a better vehicle and provide the government, central banks, with more monetary policy tools

In a somewhat more technical view, Vuong and Ngo (2002) present a discussion over the continuous existence of parallel exchange rate system,

3

To our best understanding, economists have tendency to connect and compare results within the same research discipline and analytical methodology, which severely reduced the visibility of the overall economic situation.

3 RESULTS OBTAINED AND CAVEATS

official market rate and “free-market” one In a fairly strange settings mixed between some freedom of foreign exchange hoarding by households and heav-ily regulated formal forex market, this “parallel structure” may have in part saved the local currency (Vietnamese Dong) from significant depreciation during the 1997-99 period, when the Asian financial crisis spread to chill the whole region, causing detrimental impacts on regional economies, such as Thailand, Indonesia, South Korea and Taiwan

Adam et al (2002) documented their results which support the idea that

no currency substitution has ever existed in Vietnam, despite US Dollar’s constant appreciation in value over almost the entire period post-Doi Moi The dollarization in Vietnam could be distinguished from currency substi-tution, without affecting the generality of PPP evidence as found by Vuong (2003) Their approach is to use a VECM system to decompose different effects on medium-term relationship (equilibrium), then move on to use a single-equation specification for error-correction model.4

One major result

is the conclusion that the more significant depreciation in the value of lo-cal currency, with 3 to 4 month lag, the shift to US Dollar becomes more apparent

One useful investigation on the PPP effect, following Cassel model, is reported in Vuong (2003) The controversial discussions over evidences sup-porting and rejecting PPP relationships have continued for decades now For the fledgling marketing economy of Vietnam, the evidence of this is impor-tant on two counts On the one hand, exchange rate targeting continues to be important in the central bank’s choice, at present and in the future On the other hand, the government and central bank’s intervention into the market continues to be a frequent practice However, without the confirmed PPP relationship, there would be no direction to go, except going for a completely floated system; a choice that has been impossible for any visible future Camen (2005) describes a combination of legal framework, policy strategy, monetary policy instruments and determinants of inflation altogether to put forward some key remarks of (i) transition of resposibilities for conducting policy in Vietnam to the central bank; (ii) establishing strategic target of desirable inflation; and (iii) a better clarification of the monetary policy

4

They use the popular specification ∆(m t − p t ) = αµ t −k + ∑ k −1

i=0 γ i ∆Y t −i + u t

3 RESULTS OBTAINED AND CAVEATS

strategy, including defining a more appropriate intermediate target, instead

of exchange rates

In a more general discussion by Packard (2007), channels of policy trans-missions are discussed, with author’s conclusion that it has been “a cloudy picture.” Inflation is considered in this as the primary target, but not the best A better candidate, as suggested at the end, is real exchange rate, which should take into account net effect of comparative inflation levels of trade partner countries

In the study by Le and Pfau (2008), a basic VAR specification is em-ployed to analyze the monetary transmission mechanism in Vietnam’s econ-omy They report results that support a Granger causality from increase of money supply to incremental output, at 5% significance level; or more appar-ently, industrial output Price stickiness has been confirmed, after observing results of the estimation, which basically say that a positive shock to money finally leads to an increase in general price level, which remains persistent for quite a while In brief, the results advocate the stance that instead of interest rates, exchange rate and credit channels play a pivotal role in transmitting monetary policy in Vietnam

Caveats The above reported results from academic research in the field are clearly useful to our understanding, especially when the volume of research

is so low in Vietnam

However, they do posit a number of disadvantages, which put them sub-ject to some severe limitations, both in terms of explanatory capability and real-world applications

Data sufficiency and quality: This has naturally been a severe prob-lem, to every economist wishing to conduct statistically inclined studies in monetary policy Finding proxies for economic aggregates is as difficult as obtaining the desired data The situation like Le and Pfau and Adam et al using proxies for total output is not rare, and decreases the credibility of the results obtained significantly

In the environment where economic aggregates may not be collected di-rectly from raw sources, the risk of multicollinearity is also high Violations